Economic growth looks set to remain strong in Q418. The economy was sluggish in the early part of the year as maintenance at the offshore Abu Sa'fah field weighed on oil output, leading to a 1.2% y-o-y contraction in Q118 headline growth. Production has recovered since then, however, enabling a return to growth. Meanwhile, non-oil activity remains strong, in part due to rising demand from the Gulf region which has bolstered, for instance, the manufacturing sector. A large pipeline of public and private infrastructure projects is also underpinning high levels of fixed investment. We expect these factors to continue playing out over Q418 and as such forecast growth of 3.4% in 2018. The growth rate in 2018 is therefore somewhat slower than the 3.8% increase in real GDP seen in 2017, due to the disrupted oil output in Q118.

Growth will slow from 2019 on the back of fiscal tightening. We have long highlighted the precarious state of public finances in Bahrain, with high and rising levels of government debt (80.4% of GDP in 2017) and shallow fiscal buffers ( see 'Bahrain Bailout Will Limit Risks To Short-Term Stability', June 27 2018). While Bahrain's government has largely avoided deep reforms so far, we think the upcoming bailout programme sponsored by Kuwait, Saudi Arabia and the UAE will be contingent on fiscal consolidation in Bahrain's 2019 budget. A reining in of fiscal latitude will have notable effects on domestic demand. Government capital expenditure (roughly 14% of total real fixed investment) will likely be hard hit, given that cuts to such spending are less politically controversial than, for instance, dilutions to public wages. Curbs to capital spending will consequently weaken economic sentiment. We believe that businesses will be concerned about future strains on recurrent government spending, such as public wages, subsidies and transfers, which strongly underpin consumer purchasing power. The consumer will also have higher taxes to contend with, most likely from 2019, which notably include a 5.0% value-added tax. The expected hit to consumer demand will likely weigh on firms' confidence and desire to expand, suppressing private investment.

Gulf financial support and higher exports will avoid a more dramatic drop-off in growth, however. While the government's own capital expenditure will likely be slashed in its fiscal consolidation efforts, financing from the GCC Development Fund will keep infrastructure projects going, albeit fewer than currently. As such, we expect only a gradual slowdown in growth, forecasting 2.8% in 2019 and 1.7% in 2020. The fund has tendered a cumulative USD5.1bn worth of projects in Bahrain (out of a USD10.0bn allocation) since its inception in 2011.

Meanwhile, the completion of the Line 6 Expansion Project at Aluminium Bahrain, the majority state-owned aluminium producer, will boost the company's aluminium output by 55.0%, with half of the new output being exported. Given that aluminium products accounted for a third of exports (in nominal terms) in 2017, this addition will strongly support 2019 export volumes and help prevent a larger decline in headline growth.